Sunday, March 15, 2009

–noun1. a person, usually a member of a group, who uses or advocates terrorism.2. a person who terrorizes or frightens others.3. (formerly) a member of a political group in Russia aiming at the demoralization of the government by terror.4. an agent or partisan of the revolutionary tribunal during the Reign of Terror in France.5. American International Group

Forget al-Qaida - the world's most successful terrorist organization, by a margin of roughly $170 billion dollars, exists right here in the U.S... in fact we will make it easy for the FBI - its terrorist boot camp is located at 70 Pine Street, New York, NY 10270, and they even answer the phone at 212-770-7000. The organization in question, is of course, known as American International Group. And while the U.S. has claimed it will not negotiate with any ad hoc or designated terrorist organization ever, it has time after time succumbed to every single whim and demand that AIG has raised, from shelving out hard-earned taxpayer money to make sure the company does not disappear in the gravitational vortex of its derivatives Frankenstein, to protecting its cabal of crony amateur terrorists in waiting (read CDS counterparties who benefited from every bailout, for a complete list see here), to its employees who mindnumbingly keep receiving bonus after bonus payment. And if America was any country in Europe, with a touchy-feely sense of ethical propritery, this article in the New York Times would have resulted in mass looting.

As the MSM disclosed a few days ago, Geithner, in a horrendous attempt to play Robin Hood for the masses pressured AIG to cut the $9.6 million its top 50 executives were going to receive. While that bit of information was purposefully circulated, the salvo that came from the NY Times was a bit of a fly in Geithner's ointment. Turns out AIG is paying out $165 million in "retention" bonuses over the next few days, with a range of as little as $1,000 to as much as $6.5 million for some lucky terrorist, and seven additional executives receiving bonuses more than $3 million. Now the logic for why these bonuses can not be reversed is that they were promised at some point last year, and AIG (aka US taxpayers) is contractually and legally bound to satisfy them.

This development has made some new and even more toothless Robin Hoods appear on stage center, among them Obama's chief economic advisor Larry Summers, claiming the bonus situation at AIG "is outrageous. The whole situation at AIG is outrageous. What taxpayers are being forced to do is outrageous" however "We are a country of law. There are contracts. The government cannot just abrogate contracts. Every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve system." Other politicians taking the populist flag for a spin include Republican Mitch McConnell who said:

“If you’re going to take the government as a partner, the message here, I’m afraid, to any business out there that’s thinking about taking government money, is “Let’s enter into a bunch of contracts real quick, and we’ll have the taxpayers pay bonuses to our employees." For them to simply sit there and blame it on the previous administration or claim contract — we all know that contracts are valid in this country, but they need to be looked at. Did they enter into these contracts knowing full well that, as a practical matter, the taxpayers of the United States were going to be reimbursing their employees? Particularly employees who got them into this mess in the first place. I think it’s an outrage."

Of course, none of this would have been necessary had the government done the right thing and put this bankrupt company where it belongs: into a controlled, pre-packaged or otherwise bankruptcy. Under bankruptcy law, not only would existing bonus contracts be renegotiable, but even historical bonuses would be subject to 3 year clawbacks under the terms of fraudulent conveyance. But of course, this would never happen as that would mean someone in the administration would have to make the right decision.

Which leads us to another question. As everyone now knows, the reason AIG is in its current state is due almost exclusively to the hubris of one Joseph Cassano, who would have spared the world a lot of pain if he had only read one or two of Nassim Taleb's books over the past decade realizing what 6 sigma events are and how it is in fact possible to lose up to $500 billion dollars in derivative trades. A cursory google search reveals that Cassano is a big Obama-Dodd fan (the later of DPA 2009 fame). Maybe while we are on the whole topic of fraudulent conveyance, it would be prudent for the President and the Chairman of the Senate Banking Committee to refund the over $8,900 that the individual at the core of AIG's CDS black hole had so generously provided to them in 2008... as otherwise it just might seem that he, along with his former organization, are getting some sort of preferential treatment... I am not suggesting that is the case at all, merely referring to the optics and the fact that many people are looking for pitchforks in their toolsheds. And while they are refunding Cassano's highly suspect generosity, they may also want to consider refunding the campaign contributions of Cassano's wife, Ellen Hooker as well, which came to $4,400 in 2008, and was targeted at the same two recipients. After all, we are talking about fraudulent conveyance here.

Now Cassano seems like a prudent man: he does not live in Madoff-type grandeur: his house, at 32 Minute Man Hill in Westport, CT was only evaluated at $1.2 million in 2007 (granted I have no idea of his environs in his London town house located behind luxury store Harrod's). Indeed, not only prudent, but generous: Cassano and wife apparently have a penchant for donating taxpayer money to worthy causes (his passion for all things Brooklyn is likely explained by the fact that the man who ran and subsequently destroyed the world of finance is a graduate of Brooklyn College). What confuses me, is how Cassano had a job in the first place. Taking a look at his Finra brokercheck report reveals that way before the hoopla of 2007-2008, Cassano already was in deep water with the regulators. 2004 allegations filed against Cassano, which were subsequently swept under the rug via an $80 million settlement between AIG and the SEC/DOJ, contained some serious charges:

The complaint alleged that AIG-FP PAGIC [Cassano's group] violated federal securities laws by aiding and abetting securities law violations by a public company, PNC Financial Services Group Inc. ("PNC"), in connection with a transaction entered into in 2001 with PNC that was intended to enable PNC to remove certain assets from its balance sheet. The complaint alleged that AIG-FP PAGIC knew, or was deliberately ignorant in not knowing, that the PNC transaction did not satisfy the requirements of GAAP for non-consolidation of special purpose entities.

After the $80 million settlement, the complaint was dismissed "with prejudice after the DOJ and SEC agreed not to prosecute AIG or AIG-FP in connection with the PNC transactions." Hillariously, again like in the Madoff debacle, the ultimate guilty party may again end up being the SEC. And while the Madoff fallout impacted a bunch of high net worth individuals, the SEC's light treatment of Cassano's infraction resulted in the collapse of the financial system. Yet somehow, none of the individuals who are responsible for Madoff's and Cassano's $600 billion in combined losses (and the financial system's utter collapse) are behind bars...

Maybe the American public, with its infinite patience, deserves such terrorists as AIG demanding and getting whatever they want whenever they want. One thing is certain: the SEC, while going after $20 million ponzis in Arkansas and Montana, is likely currently slapping the next Joseph Cassano on the wrist with some harsh language and a token fine, as the latter prepares to once and for all wipe out whatever is left of capitalism.

Larry Summers is outraged.. OUTRAGED at what the company did, the way it was not regulated, how NO ONE WAS WATCHING!!

F*CK YOU LARRY.

"Unless our laws and regulations relating to derivatives are modernized, we run the risk that innovation will be stifled by the absence of legal certainty, depriving the American economy of the benefits that the derivatives markets can provide, and hampering the efforts of our OTC and exchange-traded markets and businesses to compete globally."

What is amazing to me is that Geitner and Summers have rolled over so easily on this one! According to Bloomberg both public servents are 'enraged' that AIG is paying the bonuses. Alas, they concede, they can't do anything since AIG has a contractual obligation to pay the bonuses.

Bullshit - as anyone who has ever negotiated a multi-million bonus knows, nothing is paid until the cash hits your account. These bonuses are routinely contested internally and sometimes only settled months or years later on the threat of litigation.

Well, in this case, let those that wish to collect their bonuses file a public suit against AIG. Let's see how many of these crooks are going to come out and sue AIG to claim taxpayer money. Would they win? Perhaps they would - but only at the cost of having their faces and names plastered in the press. I am pretty certain that many/most of these crooks will back off and never file suit.

This would save taxpayers >50% of these bonuses and would actually give Geitner and Summers some credibility that they stood up to these crooks.

This is all part of the scam. Give us the bailouts or the lights will stop working in Peoria! We must pay these huge bonuses to our cousins or they will sue us! Bullshit! The New York Times and 60 Minutes tonight, these asshats are done.

these are all good points. after all it is only a $500 billion portfolio, so we should be able to get some portfolio manager to unwind it for $100k/year.

honestly, unless you pay good experienced people to unwind the portfolio the taxpayer is going to get even more ripped off than they have been. this certainly plays in tyler durden's favor as a trader -- if someone crap is trading the AIG/US book, he can make billions!

I sense a waft of sarcasm... however you bring up an interesting and actually very critical point. as the bulk of AIG's cds book is long risk, and presuming roughly 25% of it is in non CLO/CDO bespokes, it means there is between $50 and $100 billion worth of net notional single name CDS that AIG will have to unwind, i.e. purchase in the open market. Has anyone considered why AIG loses money as the market deteriorates? It is because as credit swaps drift wider with a declining equity and credit market, the collateral calls against AIG keep growing larger with worsening CDS MTM. Of course the US govt can stop the pain by purchasing all these CDS outright and cancelling the contracts...however doing so would blow up the entire CDS market as traders on the other side would pull all CDS offers and the govt/AIG would be left scrambling to raise bids. This is why most traders anticipate that at the moment AIG's portfolio is truly unwound (whether it is by crappy PMs or phenomenal ones), the entire CDS market will rip so wide it will blow all trading floor doors of their hinges... of course the sideeffect of this is that every single other insurance company will imedaitely be margin called into instananeous oblivion.

by blown up i meant blown wider. why? if you are stuck in a position with deep underwater option (sold CDS ala AIG) that is going more and more against you and you have to keep posting more collateral, you can either hope uncle sam suspends the entire option market (unlikely) or you can ask him to fund the unwind trade. In the CDS market spreads now are surprisingly tight compared to cash...these spreads will quickly invert if sellers of protection realize uncle sam will be buying most single name and CDO tranches to extricate AIG. When that happens CDS spreads will rip much much wideras the gov't will be forced to lift widening offers in a market that knows it can game the natural bid to whatever level it wishes. but seeing how the US has not unwound AIG's CDS book to date, i doubt it will happen. Instead it will just keep funding the collateral hole until, it hopes, ther market, both equity and credit stop declining. a very double edged sword.

why enough? i completely agree and have been pro market since day 1. from this blog to bernanke's ear...i would love to see an efficient market resolution to the problem. by delyaing it nothing is being resolved, just more and more money is being destroyed. however, and this is where i would disagree, i believe we have gotten to a point where even the market would be unable to fix the mess generated by the administrations and the capital markets. many people ask what is the way out... currently, i don't see one. plus i am amused by all these assumptions that i benefit in some way from CDS trades... i am not at all involved in the derivatives market at this point.

Ah, I see. Judging by the numbers you (and others) are throwing around about notional CDS values, ~$105B disclosed today seems like a proverbial drop in the ocean. *Many* more collateral calls to be expected then.

You also mention other insurers being in the same boat. But apart from AIG, which insurers were dumb enough to sell CDS? I thought most insurers were buyers of FI instruments not sellers of protection.

You have a great blog, I just discovered it this evening. But let me say for the record, I hope you are wrong about the insurance companies, in fact I hope and pray you are wrong. Banks collapsing is just really a very manageable event and government is actually pretty good at managing bank collapses. Insurance companies are just a completely different beast. I just hope you are wrong.

I sense a waft of sarcasm... however you bring up an interesting and actually very critical point. as the bulk of AIG's cds book is long risk, and presuming roughly 25% of it is in non CLO/CDO bespokes, it means there is between $50 and $100 billion worth of net notional single name CDS that AIG will have to unwind, i.e. purchase in the open market. Has anyone considered why AIG loses money as the market deteriorates? It is because as credit swaps drift wider with a declining equity and credit market, the collateral calls against AIG keep growing larger with worsening CDS MTM. Of course the US govt can stop the pain by purchasing all these CDS outright and cancelling the contracts...however doing so would blow up the entire CDS market as traders on the other side would pull all CDS offers and the govt/AIG would be left scrambling to raise bids. This is why most traders anticipate that at the moment AIG's portfolio is truly unwound (whether it is by crappy PMs or phenomenal ones), the entire CDS market will rip so wide it will blow all trading floor doors of their hinges... of course the sideeffect of this is that every single other insurance company will imedaitely be margin called into instananeous oblivion.

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@Tyler

your posts seem interesting but I am not sure if I am understanding you. I am not familiar with the financial jargon that you are using. Will you please re post the above in dummy language that a laymen like myself can understand? Thanks in advance.